Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 21

 

Subject:     

Accounting treatment of contribution received from a state

government towards cost of construction of a project.[1]

A. Facts of the Case

 

1. A company was incorporated in 1988 as a joint venture of the Government of India and a State Government to execute a hydro power complex comprising of a dam, two hydro power plants and a power storage plant.  The cost of the project was estimated at Rs. 2963.66 crore at March, 1993 price level and at Rs. 4982.00 crore at December 1997 price level.

 

2. Before the formation of the company, the project was being executed by the irrigation department of the State Government.

 

3. As per the articles of association of the company, the sharing pattern of expenditure between the Government of India and the State Government is as under:-

 

(a) The cost of the dam complex shall be shared between the  Government of India and the state government on the following basis:-

 

               (i) 25% of the cost of ‘power sector’ shall be borne by the state government.

 

               (ii) 75% of the cost of ‘power sector’ shall be borne by the Government of India.

 

               (iii) The entire cost of ‘irrigation sector’ shall be borne by the state government and the works relating to the ‘irrigation sector’ shall be executed by the company on deposit basis for which the entire cost thereof shall be made available by the state government.  After the completion of the project, the state government shall pay to the company every year necessary maintenance charges towards maintenance of the ‘irrigation sector’ works as mutually agreed between the company and the state government.

 

(b) The ‘irrigation sector’ referred to above shall mean 20% of the cost of ‘dam project’.  The ‘power sector’ referred to above shall mean the total sum of the following:-

 

               (i) 80% of the cost of ‘dam project’.

 

               (ii) Total cost of ‘dam project stage II’.

 

               (iii) Total cost of ‘hydel scheme’.

 

(c) The expenditure already incurred on the project by the state government shall be accounted for in deciding the part of cost sharing of the state government.

 

4. As regards the mode of financing of the cost of the power sector by the Government of India and the state government, the articles of association of the company provide as below:

 

“The Government of India and the state government are entitled to and shall subscribe to the equity and loan capital of the company in the ratio of 3:1 and this ratio shall be maintained at all times.”

 

5. As per the articles of association the sharing pattern of benefits accruing from dam project complex between the Government of India and the state government is as under:

 

(a)  The entire irrigation benefits shall be available to the state government in lieu of 100% cost bearance of ‘irrigation sector’.

 

(b) 12% of generated power at bus bar shall be available to the state government free of cost as royalty in lieu of use of natural resources of the state.

 

(c) 25% of the remaining 88% of generated power at bus bar shall be allocated to the state government in lieu of 25% contribution of ‘power sector’ by the state government.

 

(d) The remaining 66% of generated power at bus bar shall be in the central pool in lieu of 75% of cost sharing of power sector by the Government of India and shall be shared between Government of India and the state government in accordance with the standard formula evolved by the government of India.

 

(e) For supply of power to the state government and Government of India pursuant to clauses (c) and (d) above, the respected beneficiaries shall pay to the company electricity charges in accordance with approved tariff in force from time to time.

 

6. The net amount of expenditure incurred by the state irrigation department up to the date of handing over of project to the company was arrived at as Rs. 214.37 crore (irrigation sector Rs. 131.15 crore and power sector Rs. 83.22 crore).  Pending reconciliation in respect of this figure with state irrigation department, the amount is being shown temporarily in the accounts of the company under the head ‘Current Liabilities’.

 

7. As on 31.03.1998, the total expenditure on the dam project (including the works of the hydel scheme) was Rs.1642.45 crore, out of which expenditure on irrigation sector was calculated by the company as Rs. 317.05 crore.

 

8. Against the expenditure of Rs. 317.05 crore on irrigation sector as on 31.03.1998 (shown as ‘Construction work-in-progress’ in the books of account), the company had received Rs. 177.72 crore from the state government.  The amount was shown under the head ‘Current Liabilities and Provisions - Other Deposits’.

 

9. In their report, the statutory auditors observed that the net balance due from the state government, i.e., Rs. 139.33 crore (Rs. 317.05 crore less Rs. 177.72 crore) should have been shown as claims receivable under the head ‘Current Assets, Loans and Advances’.  They further observed that the manner of disclosure followed by the company had resulted in an over-statement of capital work-in-progress by Rs. 317.05 crore, over-statement of current liabilities and provisions by Rs. 177.72 crore and under-statement of current assets by Rs. 139.33 crore.

 

10. The querist has further submitted the following:

 

(a) The various components of the dam complex required to be executed for implementation of the project do not include any such component which may be distinctly termed as ‘irrigation sector’.

 

(b) Creation of irrigation facilities is only consequential to the arrangement to be made for the generation of power.  The process of construction of the project shall not result in the creation of any tangible asset related to irrigation sector.

 

(c) The entire expenditure incurred on various components of the dam complex, i.e., main dam, power house, generating units, etc. is being shown in the balance sheet as ‘Capital work-in-progress’.

 

(d) On completion of the dam complex, the expenditure booked as ‘Capital work-in-progress’ will be capitalised component-wise to arrive at the total cost of the project.

 

(e) 20% of the total expenditure required to be incurred on the construction of the project cannot be taken as actual cost of the irrigation benefits which shall be available to the state government. This is only the deemed cost of the irrigation benefits.

 

(f) The company shall be the physical owner of all the assets and structures of the dam even though the entire cost of irrigation sector component is to be borne by the state government.

 

(g) As per the normal practice, works to be executed by organisations like PWD/other government organisations against deposit of funds are required to be handed over ultimately to the agency which has placed deposits with such organisations.  However, in the instant case, no tangible asset is required to be handed over by the company to the state government.  All the assets created out of the expenditure on the construction of the project shall be the property of the company.

 

B. Queries

 

11. The opinion of the Expert Advisory Committee has been sought on the following issues:

 

(a)  Whether the accounting treatment followed by the company regarding the treatment of expenditure on irrigation sector and the balance due from the state government on this account is correct or whether the treatment suggested by the statutory auditors is correct.

 

(b) In case both the above alternative accounting treatments are not correct, what would be the correct treatment?

 

C. Points Considered by the Committee

 

12. The Committee notes that its opinion has been sought only in respect of accounting treatment of amount received from the state government towards irrigation sector. Accordingly, the Committee has not gone into the other accounting aspects of the query.

 

13. Under the historical cost basis of accounting, assets are recorded in the books of an enterprise at the cost incurred by it for those assets. Thus, for an item to be recorded as an asset, two conditions need to be satisfied, viz. (a) the item should be an ‘asset’, and (b) the enterprise should have incurred some cost for it.

 

14. The Committee notes that the ‘Guidance Note on Terms Used in Financial Statements’ issued by the Institute of Chartered Accountants of India defines the term ‘assets’ as “tangible objects or intangible rights owned by an enterprise and carrying probable future benefits”. Probability of future benefits and their availability to the enterprise (by virtue of ownership) are thus two cumulative conditions for an item to qualify as an asset of an enterprise.  In this regard, the Committee notes that the entitlement to the entire benefits from the irrigation sector is that of the state government.  Thus, even though future benefits are embodied in the irrigation sector, they will not be available to the company.  The Committee also observes that the maintenance charges to which the company shall be entitled after the completion of the project would arise on account of its maintaining the irrigation works and cannot be considered as a revenue arising out of the expenditure incurred on the irrigation facilities. Thus, from the view-point of the company, the irrigation sector does not carry any probable future benefits.  The Committee also notes that the entire cost of ‘irrigation sector’ shall be borne by the state government.  In view of the above, the Committee is of the opinion that the irrigation sector is not an asset of the company.  As such, debiting the expenditure on irrigation sector to capital work-in-progress is not appropriate.

 

15. The Committee takes note of the contention of the querist that 20% of the total expenditure on the project assigned to the irrigation sector cannot be taken as the actual cost of the project and represents only the deemed cost of the irrigation benefits. In this regard, the Committee is of the view that where a project comprising several assets is constructed, apportionment of the total expenditure incurred on the project among the various component parts on a reasonable basis is an accepted accounting practice. However, what is reasonable depends on the facts and circumstances of each case, and therefore, the Committee does not express any opinion as to whether the apportionment of expenditure between power sector and irrigation sector is reasonable or not.

 

16. The Committee notes that the ‘Guidance Note on Terms Used in Financial Statements’ issued by the Institute of Chartered Accountants of India defines the term ‘liability’ as “the financial obligation of an enterprise other than owners’ funds”.  In this regard, the Committee observes that the company has no financial obligation towards the state government in respect of the irrigation sector. Its commitment is merely to maintain the irrigation facilities after the completion of the project and, for this, maintenance charges would be paid to it by the state government. Accordingly, the Committee is of the view that the sum of Rs. 177.72 crore received by the company from the state government towards the expenditure incurred by it on irrigation sector is not a liability of the company and, therefore, its inclusion in the balance sheet as a current liability is not appropriate. Instead, it should be reduced from the total expenditure incurred on the irrigation sector (i.e. Rs.317.05 crore) and the net balance (i.e. Rs. 139.33 crore) shown as a receivable under the head ‘Current Assets, Loans and Advances’.

 

D. Opinion

 

17. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 11 above.

 

(a) The accounting treatment suggested by the statutory auditors is correct. The net balance due from the state government, i.e., Rs. 139.33 crore, should be shown in the balance sheet as a receivable under the head ‘Current Assets, Loans and Advances’.

 

(b) See (a) above.

 

________

 

[1] Opinion finalised by the Committee on 28.5.1999.